Jokester’s question: “What is the easiest way to make a small fortune?” Jokester’s reply: “Start with a large fortune.”
Of course, how do you make a large fortune in the first place? The answer is: “Start small, think smarter, and work harder.”
Learning how to be successful at investing may not require actual physical exertion, but to be successful requires effort – and the more effort put into learning and gaining experience, the more successful your investing will be. How successful is up to you.
Rules of the Road
Investing is not a science; there is an art to it, and each investor must figure out what works for him – not for his buddy, not for anyone else. Successful investing takes personal skills and knowledge. Everyone learns the basics, the technical details of making trades, the general vocabulary. After that, you build your own capability based on your own interests and experience.
Making mistakes is part of the process. Warren Buffett is a very successful investor, but he will be the first to say that he has made a great many costly mistakes.
But perseverance is one character trait all investors must have: don’t quit; don’t give up. Learn from every mistake – and learn from every success. Learning is essential; it never stops. Warren Buffett is over 90 years old, but he is still learning.
Another investor is only slightly less famous: Bill Ackman of Pershing Square. If Warren Buffett is the calm, staid, conservative, deliberate investor, Bill Ackman is the opposite: aggressive and even controversial.
Like Warren Buffett, Bill Ackman makes his share of bad investments; some of them have been real losers. But overall Pershing Square has been a success. It is now one of the largest and most successful hedge funds.
In 2012, Ackman bought enough shares of Canadian Pacific (CP) Railroad to take a number of seats on the company’s Board. He then hired Hunter Harrison to be the new CEO. Harrison radically improved their operations, and CP’s stock went way up. Ackman and Harriman then did the same thing at CSX Railroad. Investors who owned CP and CSX stocks made lots of money.
Keeping up on the news about stocks you have bought or might buy and about successful investors can really help your success as well.
Tax breaks for the rich?
January’s Investors Column reviewed 401ks, IRAs, and Roth IRAs. The more money you can invest in them, the bigger will be your returns.
You have seen headlines sensationalizing “tax breaks for the rich”, but one of the best tax breaks is available to all of us: 401ks and IRAs. Take advantage of your tax breaks to build your wealth much more quickly – while lowering your tax bill.
Most financial advisers will recommend a mixture of investments in stocks and bonds. Bonds grow in value more slowly, but also drop in value less than stocks during downturns. Most people by nature are risk-averse, and tend to be frightened by losses in stock-market downturns, even blaming their adviser. Investing in a mixture of stocks and bonds minimizes the fluctuations a financial adviser’s customers will see. That mixture shields them from the fact that investing feels very risky.
But if you can learn to live with a greater amount of risk, you can enjoy greater returns from your investments. Great returns year after year minus a little in a downturn beats a more conservative approach; just ask Buffett and Ackman. If your investments give above-average returns year after year, in the long run you will be ahead.
Which strategy you pick is up to you.
Don’t get out of investing because of a downturn in stock prices. When stock prices drop, that is the best time to buy stock.
Never sell stocks when the market falls. Never be disheartened. A dip is followed by a return to the previous price – usually, very quickly. Recovery times are where good investments really pay off. Good stocks recover from a dip more quickly than the average. Stay invested. Quitters are losers.
On a downturn, ask yourself, “Is this a good price to buy the stock(s) I own?” If you already own stock in good companies, the answer will usually be, “Yes.” If so, don’t sell. Hold on to it.
When to sell
Downturn or upturn, any time your research shows that one of your investments has become less likely to have gains over 10% in the future, sell it, and buy a stock that will have better performance.
How many stocks should I own?
As your investments grow, spread your portfolio to include about a dozen stocks. A diverse portfolio protects you from downturns in one stock or group of stocks (e.g., finance vs. manufacturing vs. hi-tech).
Keeping up with the status and news about each of your stocks can be time-consuming. Owning a dozen stocks allows a diverse enough portfolio while still being able to stay aware of relevant news.
Use the investing apps available on your smart-phone or tablet to keep a “watch list” of market indexes stocks which are of interest to you.
Measuring your success
The Dow Jones Industrial Average and the S&P 500 average about 10% gains each year. Most good mutual funds average 12%. Your investing goal is to beat both averages.
Set incremental goals for your investing. As you reach a goal, set a new, higher goal. When you reach $10,000, aim for $15,000. When you reach $100,000, aim for $120,000. Working to reach each new goal is a healthy incentive to push yourself towards success.
If you are married, both of you should invest, not only in 401ks and IRAs, but also in after-tax accounts. Make it a friendly game: “I beat my wife today.” “That’s okay; I beat him every day last week.” The game provides terrific incentive to make successful investments. You both win.
Your lifestyle now
Many people buy the most expensive house they can afford. Buy a house that is nice, but slightly smaller, or in a less expensive neighborhood. Buy a less expensive car. Make dining out a special occasion – once a week, or even once a month. Buy groceries; take a self-prepared lunch to work each day. A married couple can divide the workload: if one makes the meal, the other cleans up afterwards. Mow your own lawn.
Pay off your house before you retire, as well as any other loans.
Choices like these make you more frugal with your money. That extra money can then be put to work through investments. “A penny saved is a penny earned”, but a dollar invested earns many dollars.
Make your money work for you.
Calculate how big your investing has to grow to support the way you want to live once you retire. Assume Social Security will not provide significant support.
Goal One: Calculate the amount you will need invested to live comfortably to an age five to ten years beyond your expectation based on family history.
Once you reach Goal One, set Goal Two: Calculate how much you will need so that, if your investments continue growing at 10% per year, you can live on that 10%, and never touch the base amount. In other words, how much money will you need so that your total amount invested will grow faster than you intend to spend it?
Finally, set Goal three: Grow your investment to $1,000,000 by the time you retire. Retire as a millionaire! An annual gain of 10% on a million is $100,000! With a frugal lifestyle, you will be earning money faster than you can spend it. Even if there is a downturn for a couple of years, you will be unaffected.
Next Month: What are Mutual Funds?■